Worried About Ahmadinejad, Chavez And Putin? Stabilize The Dollar

Mahmoud Ahmadinejad’s Iran is moving its uranium enrichment centrifuges underground to protect its atomic bomb program from attack. Under the leadership of Vladimir Putin, Russia has announced a $635 billion rearmament program, saying that it intends to buy 600 new planes, 1,000 new helicopters, and 100 new ships over the next 10 years. Venezuela is fomenting Hugo Chavez’s “Bolivarian Revolution” throughout Latin America.

How can we counter these threats to our national security? Before we send in the Marines, we might consider stabilizing the dollar. A strong dollar was one of the principle weapons that Ronald Reagan used in the 1980s to topple the Soviet Union, which was a far more formidable adversary than any that we are facing today.

When Reagan took office in January 1981, the USSR was on the march. It had invaded Afghanistan in 1979, and supported the Sandinista takeover in Nicaragua that same year. The Soviet leader, Leonid Brezhnev, had proclaimed the “Brezhnev Doctrine”, under which the advance of communism was deemed to be irreversible.

Reagan launched a massive arms build-up, but none of the weapons he bought were ever used against the USSR. By stabilizing and strengthening the U.S. dollar, Reagan sent oil prices tumbling in real terms, thus crashing Soviet hard currency earnings, thus breaking the back of their economy.

In January 1971, during the last days of the Bretton Woods gold standard, the free market gold price was $37.88/oz and crude oil was selling for $3.56/bbl. Adjusted via the GDP deflator, $3.56/bbl in 1971 dollars amounts to $16.02/bbl in 2011 dollars.

By the time that the Soviets invaded Afghanistan, in April 1979, gold was trading at $239.36/oz and real ($2011) crude oil prices had risen to $41.34/bbl. Real Soviet oil export earnings per barrel had increased by 158% from 1971 with no effort on their part.

When Reagan was inaugurated, gold prices were $499.02/oz and real crude oil prices were $84.51/bbl, more than five times what they had been ten years before.

Reagan supported Federal Reserve Chairman Paul Volcker’s determined attack on inflation, including appointing him to a second term in the depths of the 1981-1982 recession. By March 1985, when Mikhail Gorbachev became General Secretary of the Communist Party of the Soviet Union, gold prices had eased to 304.47/oz and real crude oil prices had declined to $52.24/bbl.

By March 1986, real crude oil prices had declined to $22.85/bbl, and Gorbachev knew he was in trouble. The USSR had lost 73% of its oil export income in real terms.

Four more years of low real crude oil prices brought the Soviet regime to the brink of bankruptcy. In May 1990, Gorbachev called German Chancellor Helmut Kohl and begged him for a loan of 20 billion deutschmarks to stave off financial disaster. Kohl advanced only 5 billion. By August of 1990, Gorbachev was back, pleading for more loans. In December 1991, the Soviet Union collapsed.

The strategy that Reagan used to bankrupt the USSR can and should be used against Iran, Venezuela, and the Soviet Union’s successor state, Russia.

Right now, gold is selling for $1650/oz. Crude oil is trading at $83.18/bbl, which, in real terms, is almost exactly the same as when Reagan took office. At present, an ounce of gold will buy almost 20 barrels of crude oil, which is high in historic terms. Over the past 40 years, the average crude oil/gold ratio has been about 15 barrels per ounce.

Congressman Ted Poe has introduced into the 112th Congress a bill to stabilize the dollar. H.R. 1638 would require the Federal Reserve to name a date and time certain, some months from the enactment of the law, and then to stabilize the value of the dollar at the COMEX price of gold at that moment in time. This price would then become the Fed’s target gold price. Thereafter, the bill would require the Fed to maintain the target gold price directly, via Open Market operations, rather than by manipulating interest rates.

Current gold and oil prices reflect inflation that is expected and feared, not just inflation that has already occurred. If H.R. 1638 were to pass, gold prices would plummet, taking crude oil prices with them. If we were to assume that gold was really worth $35/ounce in December 1958, then an appropriate target gold price would be about $222/oz. On the other hand, if gold was really worth its market price of $379.26 in December 1994, then we could expect a target gold price of about $532/oz. It doesn’t matter what the target gold price turns out to be, but let’s go with the $532/oz number.

Stabilizing the price of gold at $532/oz would stabilize the value of the dollar at 0.001879699 ounces of gold. Based upon the historical relationship between gold prices and crude oil prices, we could then expect crude oil to settle at around $35.50/bbl. This would, among other things, reduce the price of retail gasoline to well below $2.00 per gallon.

A crude oil price of $35.50/bbl would cut the oil export earnings of countries like Iran, Russia, and Venezuela by about 57% from where they are today. This would quickly put a damper on their ability to cause trouble. Over time, it could even bring regime change, as it did in the case of the Soviet Union.

To have a stable economy and stable financial markets, we must have a stable dollar. A stable dollar is also required for fast economic growth, full employment, and true prosperity. It is a bonus that something that would be so good for America would also be so bad for our adversaries.

I am a software entrepreneur who is currently an investor and board member in three startup companies. I have a B.S. in mechanical engineering. I was born in 1948. This chapter of my life is about trying to help people make their dreams come true. I started writing about ec...